When using cash is better than credit

How much does it cost you to live cash-free?

JeanettePavini

Award-winning broadcast journalist and author Jeanette Pavini writes the Buyer Beware column for MarketWatch and wants to hear your stories, questions, problems and complaints. Write to her at BuyerBewareMKTW@gmail.com.

SAN FRANCISCO (MarketWatch) — We work on our relationships. If our marriage is in crisis, we go to a marriage counselor. We take parenting classes to improve our relationships with our children. There are girls’ night out and the guys’ weekend getaways to keep those relationships intact. But what ever happened to our relationship with cash?

As my 87-year-old father watched his children and grandchildren make purchases using credit, lines of credit and “special financing,” he would say, “In my day when you earned a quarter, we would spend fifteen cents and save a dime. These days you spend the whole quarter, then borrow another quarter at 22% interest.”

He’s of the “envelope” generation, where you would have envelopes in which you’d place the cash to cover each of your budget items for the week or month: groceries, gas, entertainment and so on. When the cash was gone, you did without until your next paycheck. He had a relationship with cash. He held it in his hand and turned it over. He knew how much he had.

So the question is, do we turn over less of our money if we pay in cash as opposed to using plastic? And why?

MIT researchers found that people spend more if they are in a setting where they are able to use credit cards. Catherine Tucker, a professor at MIT Sloan School of Management, said, “I think the question is not whether consumers have a healthy relationship with cash, but whether they have an unhealthy relationship with credit cards.”

So how do you know if you are stuck in an unhealthy relationship and need to get out? Consider two things: Are you buying things you wouldn’t buy if you were paying cash for them? Secondly, are you able to pay off your credit cards each month?

Tucker said, “For people who are able to control their spending and able to pay in full each month, credit cards are preferable. They give limited forms of purchase protection and it is possible to earn various rewards for using them. However, for people who have problems controlling spending then using cash may be preferable.”

For some of us, there may be a strong psychological reason that motivates us away from cash and toward plastic.

Accoring to George Lowenstein, a professor of economics and psychology at Carnegie Mellon University who has done extensive research on this psychological connection, “People experience what my research collaborators and I call a ‘pain of paying’ when they pay for purchases, and this pain is more intense with cash than with cards. Paying with cards is more carefree.”

Lowenstein said that the downside of the ease of spending with credit and, to a lesser extent, debit cards is that the diminished pain of paying encourages overspending and almost certainly increases the likelihood of going into debt. “Very few people who end up with a $5,000 balance on their credit card at the end of a year would have agreed to take out a $5,000 loan at the beginning of the year to fund miscellaneous expenses.”

In fact, if that $5,000 is put on your credit card at 22% interest, by making a payment of $100 a month you would have the balance paid off in 10 years and 11 months. The interest you would pay on that $5,000 is an additional $7,683.48 for a total of nearly $13,000.

Suddenly, the price of that cup of coffee has become long-term debt. Remember, cash doesn’t accumulate interest — which is something you need to consider every time you swipe your credit card, if you don’t pay the balance off every month.

Joe Priester, an associate professor of marketing at the USC Marshall School of Business and the former president of the Society for Consumer Psychology, said, “Money is not as psychologically real when it is in the form of credit, so it is easier to spend more, especially on unplanned and/or impulse purchases. There is even evidence that we spend more money when merely presented with credit-card logos when entering a store or at checkout. In a way, credit cards prime our spending, often on an unconscious level.”

And it seems consumers rationalize that they indeed will have enough money to pay for the purchase in the future. “You can think of the Popeye cartoon in which Wimpy is always saying, ‘I’ll gladly pay you Tuesday for a hamburger today.’ Wimpy most likely truly believes that he will have the money next Tuesday. He seldom does. Similarly, we most likely truly believe that we will be able to easily pay for the extra purchases in the future. And we often don’t.”

But in theory, Popeye’s Wimpy may have had a good idea. Credit is one of the most valuable things consumers can have, as long as they know how to use it. There are tremendous financial advantages to establishing good credit. You may qualify for lower interest rates on things like mortgages, which can save you thousands of dollars in the long run. You can accumulate reward points for cash back or free merchandise. Using a credit card can offer additional protection, and it creates a record of responsible behavior.

Whether spending with cash or credit, you should keep track of your daily spending if you want to save money.

According to Priester, “Merely keeping track of where and how we spend money influences how we spend money in the future. This is true for a wide variety of our behaviors. The mere monitoring of that behavior can change the behavior. The more able one is to keep track of one’s spending, the more that spending will become consistent with goals.”

Cash has its advantages, too. It gives us more conscious accountability for our spending. Cash can be an excellent tool for managing our daily expenses. Research at the University of Chicago showed that we all have a natural tendency to “mentally account” for expenses.

Priester said, “We psychologically place money in various mental accounts and have difficulty switching money from one account to another.”

Before the era of electronic fund transfers or ATMs, the cash-envelope system did just that. These days we have modern high-tech envelope systems. There are apps for our cell phones; some banks offer a “virtual wallet,” and some websites like Mint.com alert you when one part of your self-set budget has been exceeded.

So, let’s stop right here. Dig deep into your wallet. How much cash do you have on hand? Is it enough to help you in the event of an emergency should ATMs be down? Do you have enough to buy your morning cup of coffee?

Now, think back to the last lunch you bought or bag of groceries. Did you use cash or pull out plastic? It just seems we no longer carry cash. Ironically, as I was writing this article I stopped into a coffee shop. I reached into my wallet to pay the $2.65 for my hot chocolate and sure enough had to go for the credit card. In fact, many of us do pull out the credit card for our latte and swipe it for movie tickets — even parking meters in some cities now let you charge as little as a quarter.

As consumers we even react to the denominations of the cash we carry. Leif Nelson, an associate professor at the Haas School of Business at Berkeley, cited a study by the Journal of Consumer Research which found that people are more likely to spend smaller denominations of the exact same amount of money. For example, it’s easier to spend five $20 bills than it is to spend a single hundred-dollar bill.

This all comes back to developing that relationship with cash. Not an ATM card or a credit card but cold, hard cash. Stick with cash for day-to-day expenses and use credit cards carefully, and with forethought, for larger, planned expenses, advised Priester.

This can help to make us all more aware of just how much we are spending, which is the key to saving money. And my dad is living proof that it works. He never earned more than $45,000 a year, and Mom was a homemaker. They put five kids through private schools and braces. Now my folks are in their 80s. They own their home and two cars, have retirement set aside and zero debt. They still have a very healthy relationship with their old friend, cash — who still has a place in an envelope in their drawer.

Jeanette Pavini is a regular contributor to various publications and Better.TV. She also hosts the weekly TV series, “The Real Deal” on NBC Bay Area and is the national spokesperson for Coupons.com. Write to her at BuyerBewareMKTW@gmail.com.

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Jeanette
Pavini

Emmy Award-winning broadcast journalist, documentarian and author Jeanette Pavini covers consumer and investigative news for numerous publications, radio and television. Jeanette is based in the San Francisco Bay Area. Follow her on Twitter @jeanettepavini.

Jeanette
Pavini

Emmy Award-winning broadcast journalist, documentarian and author Jeanette Pavini covers consumer and investigative news for numerous publications, radio and television. Jeanette is based in the San Francisco Bay Area. Follow her on Twitter @jeanettepavini.

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